Dividend Impetus To Buy Chesapeake Granite Wash Trust

Nov.14.11 | About: Chesapeake Granite (CHKR)

I purchased Chesapeake Granite Wash Trust (NYSE:CHKR) recently as a new long term dividend holding. The trust has a strong institutional partner in Chesapeake Energy Corporation (NYSE:CHK). I own the trust based upon the conviction natural gas will remain stable and provide ample support for the expected dividends thru 2015 and beyond.

My goal is to receive my cost of invested capital back in the early years. Secondly, I expect positive cash flow from the remaining years after the partially hedged years thru 2031.

Dividends

I believe in the core investing aspect of ensuring my return of invested capital is received back. Return on capital is the additional return of dollars based upon the assumption my initial investment dollars are back in my cash till.

Investors will note the high return of capital during the 2011 through 2015. The high return of capital is exceptional. Ideally investors seek insurance of their return of capital and, then, a return on invested capital.

Hedges

The trust will hedge a portion of its oil and natural gas liquids production through September 30, 2015. The Chesapeake Granite Wash Trust will hedge approximately 50% of the expected oil and natural gas liquids production and 37% of the trust’s expected revenues. The time frame, for the hedge productions are October 1, 2011 through September 30, 2015 (CHKR, S-1/A SEC filing, page 9).

Click to enlarge

The above table shows the hedge production costs and unhedged production costs.

Background

Chesapeake Granite Trust was established by Chesapeake Energy to own and provide distributions from specific royalty interests in oil and natural gas wells. 20 million units were sold for $19 per unit. The stock closed, on its first day of trading, at $18.74.

The royalty interests will be conveyed from Chesapeake’s interest in the producing Wells and the in development Wells effective as of July 1, 2011. As of July 1, 2011, 64 of the Producing Wells were producing from the Colony Granite Wash and the remaining five in production wells had been drilled and were awaiting completion. As of October 28, 2011, all of the in production wells were completed and producing. The royalty interest in the producing wells entitles Chesapeake Granite Trust to receive 90% of the proceeds from the sale of production of oil, natural gas liquids (ngl) and natural gas attributable to Chesapeake Energy's net revenue interest. The royalty interest in the in development wells entitles the Chesapeake Granite Trust to receive 50% of the proceeds from the sale of oil, ngl's, and natural gas production.

Granite Wash

Granite Wash is material eroded from granites and redeposited, forming a rock with similar mineral elements as the original rock. This means Granite Wash received its name from the time and weathering process that granite experienced over a specific time duration.

Chesapeake Energy Residual Ownership

Chesapeake Granite Trust will possess royalty interests conveyed by parent Chesapeake Energy. The royalty conveyance will entitle Chesapeake Granite Trust to a percentage of hydro carbon proceeds.

Location of Granite Wash Trust Wells

The Chesapeake Granite Trust core assets are 69 in production wells and 120 in development wells. The "in development" wells will be drills on the 45,400 gross acres located on the Colony Granite Wash play in Washita County in the Anadarko Basin of western Oklahoma.

Linn Energy, LLC (LINE) is a recent acquirer of Granite Wash properties. In this article, "6 Must-Buy Justifications To Buy Linn Energy", Linn Energy management is enthusiastic about the Granite Wash acquisitions. The low risk profile of the properties fits Linn Energy's business model.

Risks

The key risk is only 37% of total expected revenues are hedged thru September 30, 2015. This differs in comparison to a minimum 54% hedged production, during early years, for recent offerings SandRidge Permian Trust (NYSE:PER) and SandRidge Mississippian Trust I (NYSE:SDT). Investors in SandRidge Permian Trust and SandRidge Mississippian Trust I know that 100% of oil and natural gas production through 2015 are hedged.

The key risk is natural gas will decrease from present prices in future years. Historically speaking, natural gas is at fairly level or even low levels. Oil prices are hedged to a certain extent, but certainly not the 100% level of SandRidge Permian Trust and SandRidge Mississippian Trust I.

Positives

The key positive attribute is a strong partner in Chesapeake Energy Corporation. The parent company is a $16.8 billion market capitalization entity. Aubrey K. McClendon, the chief executive officer (CEO), is a well known oil and natural gas investor in North America. A strong partner is a major plus due to the reduced risk of capital loss due to counter party risk.

The significant returns of capital during the years is simply a positive. In the day and age of turbulent markets, return of capital has become a personal fundamental investing goal.

Action Plan

Based upon the strong partner, I believe Chesapeake Granite Wash Trust is an ideal investment for those with an appropriate risk tolerance and awareness of the business model.

I like to see Chesapeake Granite Wash Trust trade below its offering price. This ensures to me an opportunity to acquire shares at the offering price. My focus is to ensure the shares are not bid up to unreasonable valuations. This is a long term dividend play. The stock doesn't have the "excitement" and "growth potential" of a Groupon, Inc. (NASDAQ:GRPN). The hype of a Groupon, Inc. often fades with time, and the constant dividend of a Chesapeake Granite Wash Trust pays off for years to come.

The Chesapeake Granite Wash Trust will dissolve and begin to liquidate on the termination date, which is June 30, 2031 (page 19). I believe the partially hedged production (thru September 30, 2015) and unhedged production thru June 30, 2031 will be a profitable investment.

Disclosure: I am long CHKR, LINE, SDT, PER.